Government Annulment; What You Need To Know About The Anti-Assignment Act While Waiting For The Government Contracts Lawyer To Show Up.

August 1, 2007

Government Contracts CPR Redux: In the first of these short memos we discussed the two circumstances that required an immediate legal response even before the government contracts lawyer hasn’t shown up yet, federal investigations and bid protests. We also promised to address when and how to start an adversarial process with a government customer. Unfortunately, we were side-tracked with client concerns about selling and financing government contracts businesses. This led to the need to explain in detail the federal Anti-Assignment Acts and we decided to pass that explanation on for your amusement.

“Annulling” Government Contracts: Selling to the government or buying or lending to government contracting businesses can be full of delightful traps for the unwary. Today’s curiosities are the Anti-Assignment Acts. If you are a litigator or corporate attorney or represent lenders, you already know what fun it can be to deal with so-called anti-assignment clauses. For the last century and a half, the federal government has had a doozy. Contracts with the federal government assigned in violation of the Anti-Assignment Acts (31 USC 3727 and 41 USC 15} are unenforceable against the government, “annulled” to be precise. But never fear. Thanks to Congress, loopholes abound.

As you would suspect, the problem comes up most often when transferred corporate assets include government contracts and when a borrower wants to use government receivables as collateral. Naturally, each situation has a unique, paper intensive solution. This is the government after all.

The M&A Scenario: When acquired corporate assets include government contracts, the contracts are in some fashion assigned to the buyer. Because of the prohibition against assignment of contracts with the federal government, this can appear to be a problem, but doesn’t need to be. First of all, if you are dealing with a stock purchase and the target corporation remains in existence after the sale, the government generally won’t care. As far as they are concerned, they are still dealing with the same corporation. As a buyer, the government is usually unconcerned who owns the stock. Companies with facility security clearances are an exception; they will know who they are and what a change of ownership means to them. Exon-Florio concerns would raise other ownership issues regardless of the type of acquisition.

On the other hand, if the sale is accomplished by asset transfer or the target corporation is no longer in existence after completion of the transfer, there will be an assignment that is technically a violation of the Anti-Assignment Acts. There is one very simple (and generally unavoidable) way of solving this. Get the government’s consent. The Anti-Assignment Acts do not impact the validity of the assignment as between the assignor and assignee. They are only for the government’s protection and the government, either by consent or implication, can waive that protection.

Now you will find lots of case law to the effect that the Anti-Assignment Acts do not apply where the transfer of the government occurs by “Operation of Law”, e.g., mergers, reorganizations. This precedent is great if you are in litigation but not particularly useful in advising clients entering into an asset sale, assuming they wish to avoid litigation.

The only way to get the government’s express consent to a transfer of a government contract so that the buyer will be acknowledged by the government as being in privity is to enter into an agreement the government calls a Novation. This is a three-party agreement between the buyer, seller and the government. It is an agreement separate from the agreements constituting the sale and its only real purpose is to get the government’s consent to the transfer of the contract (or contracts). The regulations (48 CFR Subpart 42.12) have a “suggested” form of the novation agreement that must be adapted to the situation, but don’t expect contracting officers to agree to depart from this form in any material way. This form isn’t a novation agreement in the traditional sense because it has the seller continuing to guarantee the performance of the contract by the buyer. This guarantee provision needs to be addressed in the agreements between the buyer and seller with appropriate warranties. Consent to transfer of contracts associated with an asset sale is voluntary on the part of the government, but under most circumstances contracting officers will go along with a novation agreement. A refusal by the government to consent to the assignment can also be addressed in the sale agreements. In requesting a novation, you should note the fairly extensive documentation of the asset sale that is required by the regulations.

Financing Government Contractors: Receivables tied to federal government contracts make very attractive collateral. After all, the receivable’s payor is self-defined as solvent, all indications to the contrary notwithstanding. And why not. If the federal government can’t pay its contractors, failure of specific collateral is going to be the least of your client’s problems. But more than being a credit worthy payor, the federal government automatically pays interest on invoices not paid in a timely manner thanks to the cleverly named Prompt Payment Act.

Because of the Anti-Assignment Acts, prior to 1940, banks could not create an assignment that gave them any rights against the government if payments were made to the borrower rather than the assignee. Now, by carefully following the requirements of the somewhat misnamed Assignment of Claims Act and implementing regulations (48 CFR Subpart 32.8), a financing institution can assure that the government will make payments only to the assignee and that the government will be liable to the assignee if payments are misdirected to the borrower.

Assignment of government contract proceeds as collateral is now very doable and routine, but there are lots of ways to mess things up. First, the assignee cannot be just anyone. The assignee must be a bank, a trust company or some other financial institution. For successful assignment of a contract’s proceeds, the contract must provide for payments of at least $1,000 and must not specifically prohibit such assignments. The assignment must be for all proceeds under the contract, be made to one assignee (who can act as agent for multiple sources of financing), and not be subject to further assignment. Also the assignment cannot be merely a security interest in the contract proceeds but must transfer ownership in the proceeds to the assignee. And the assignment is only of the contract proceeds; no privity of contract between the government and the assignee is created.

Now comes the really tricky part where most government contract assignment problems show up: notice. The government must have actual notice of the assignment. By its actions, the government can be held to have waived that requirement, but it is so much cheaper just to make sure notice was received in the first place. The regulations are replete with very detailed procedures to follow in order to provide effective notice. In general notice must be received by the contracting officer, the disbursing office and any surety. There is some good news. Once the payment is received by the assignee, the government cannot recoup it on the basis of any liability of the assignor for any reason short of fraud.

If the government screws up and pays the contractor even though there is a valid assignment in place, the assignee can sue the government to recover the payment (but not for breach of contract), but must go the U.S. Court of Federal Claims to do so.

One final note. Plaintiffs seem to regularly try to sue the federal government on unliquidated claims that have been assigned to them by the real party in interest. As a rule, this won’t work. If a potential plaintiff shows up at your door with a case against the feds based on an assigned claim, you will be in for some heavy lifting if you decide to take the case.